Journal of Financial Economics 101 (2011) 227242

Contents lists available at ScienceDirect

Journal of Financial Economics

journal homepage: www.elsevier.com/locate/jfec

International diversication with frontier markets$

Dave Berger a, Kuntara Pukthuanthong b, J. Jimmy Yang a,n
a
b

College of Business, Oregon State University, 200 Bexell Hall, Corvallis, OR 97331, USA
College of Business Administration, San Diego State University, USA

a r t i c l e i n f o

abstract

Article history:
Received 13 May 2010
Received in revised form
10 September 2010
Accepted 13 October 2010
Available online 25 February 2011

We provide an analysis of frontier market equities with respect to world market

integration and diversication. Principal component results reveal that frontier markets
exhibit low levels of integration. In contrast with developed and emerging markets,
frontier markets offer no indication of increasing integration through time. Furthermore, individual frontier market countries do not exhibit consistent rates of changing
integration. Structural break tests identify breakpoints in integration, as well as
integration dynamics across countries. We show that frontier markets have low
integration with the world market and thereby offer signicant diversication benets.
& 2011 Elsevier B.V. All rights reserved.

JEL classication:
F15
G15
Keywords:
Frontier markets
International equity markets
Market integration
International diversication

We study the potential diversication benets of

frontier markets by measuring integration dynamics, as
well as analyzing frontier market exchange-traded funds
(ETFs). Frontier markets are smaller, less accessible, yet
still investable countries in the developing world; the
median market capitalization of frontier markets within
our sample reached US$12.89 billion at the end of 2009.
When their capital and liquidity increase, frontier markets
may be reclassied as emerging markets. This designation
originated in the 1990s, when Standard and Poors (S&P)
started to track a representative index of frontier markets,
then became prominent in 2007 when S&P launched its
Select and Extended Frontier Indexes.1 To reect growing

investor interest in these markets, MSCI also launched a

Frontier Markets Index late in 2007. Recently, frontier
market mutual funds and ETFs also have emerged.2
Despite the signicant attention to frontier markets
among the investment community, very little research
includes them. Frontier markets may offer promising
diversication benets; for example, Speidell and
Krohne (2007) document low correlations between frontier and developed market equities. Jayasuriya and
Shambora (2009) study diversication benets across
market classications and consider optimal portfolios of
developed, emerging, and frontier markets. They nd
improved portfolio risk and returns when investors diversify their portfolio into six frontier markets. Cheng, JahanParvar, and Rothman (2009) use variations of the CAPM to

$
We thank an anonymous referee and the editor, Bill Schwert, for
many helpful suggestions. We have also beneted from the comments of
Hsuan-Chi Chen, Hui Guo, Keng-Yu Ho, Yong Kim, and Laurens Swinkels.
n
Corresponding author. Tel.: + 1 541 737 6005; fax: + 1 541 737 4890.
E-mail address: jimmy.yang@bus.oregonstate.edu (J. Jimmy Yang).
1
According to Kim (2010), MSCI has returns for frontier markets
that go back to May 2002, while S&Ps Frontier Index (which excludes
the Gulf countries) extends back to 1996.

2
On March 17, 2008, Barclays Global Investors (BGI) launched the
BGI Frontier Markets Fund, which invests in 16 frontier markets and
benchmarks against the MSCI Frontier Markets Index. Franklin Templeton Investments introduced its Templeton Frontier Markets Fund, the
rst actively managed, US-registered frontier market fund, on December
9, 2008. Deutsche Bank launched the rst frontier market ETF in Europe
in early 2008. The Bank of New York Mellon created its frontier market
ETF in June 2008.

1. Introduction

0304-405X/$ - see front matter & 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.jneco.2011.02.009

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D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

study nine emerging and frontier equity markets within

the Middle East and North African region. They nd that
most markets within their sample exhibit low levels of
integration, but they also nd that both global and local
risks are priced.
To enhance understanding of frontier markets, we conduct several analyses across frontier market countries, as well
as across broad frontier market indexes that include up to 25
frontier market countries. Constructing these broad frontier
market indexes strengthens our results by providing a
lengthy sample period and minimizing country-specic
noise. This analysis therefore details the relations among
small and illiquid markets worldwide.
In contrast to our study, most research on international
market integration and diversication focuses on developed
and emerging market asset classes. For example, Solnik
(1974) argues that international diversication is benecial
on the basis of cross-market correlations. Odier and Solnik
(1993) nd that despite increasing informational integration
across markets and greater correlation during volatile periods, overall international correlations remain low, so international diversication is still benecial. In their study of
diversication benets, Driessen and Laeven (2007) consider
developed and emerging markets and emphasize diversication benets for local investors. They nd that international
diversication is most benecial for emerging market investors. However, focusing on downside risk and allowing
for conditional correlations, You and Daigler (2010) nd
little evidence of international diversication benets.
Recently, Rua and Nunes (2009) use wavelets to study
cross-market correlations within developed markets and nd
that the US and UK stock markets exhibit the highest
comovement across time while the Japanese market shows
a low degree of comovement with other major stock markets.
From an asset-allocation perspective, cross-market correlations are clearly informational, but Carrieri, Errunza, and
Hogan (2007) argue that they do not provide a complete and
accurate measure of diversication benets or overall integration. They provide the example of Zimbabwe, in which a
high correlation between the worldwide price of copper and
the national market does not indicate a highly integrated
capital market. Pukthuanthong and Roll (2009) also consider
cross-market correlations inadequate as measures of integration. Varying market sensitivities to international factors can
lead to low correlations, despite high levels of integration.
Furthermore, integration varies through time, and tends to
increase for many countries, though some specic countries
become less integrated over time (Pukthuanthong and Roll,
2009). Bekaert et al. (2007) propose the use of global growth
opportunities to measure market integration with price-toearnings ratio comparisons, as an alternative to correlationbased measures.
We apply Pukthuanthong and Rolls (2009) measure of
integration to broad market classication indexes and nd
that developed and emerging markets exhibit signicant
exposure to the world market factor. However, there is little
evidence of integration between frontier market indexes and
this factor. For developed and emerging market indexes,
levels of integration increase signicantly through time; the
broad frontier market indexes in contrast offer no evidence of
increasing integration. We also extend Pukthuanthong and

Rolls (2009) approach that measures integration through

time. Specically, we allow for structural breaks in a timetrend model and apply our proposed method to a sample of
frontier market countries. For any given country, breakpoint
tests indicate the calendar month in which the level of
integration shifts or the rate of integration changes. Therefore, this approach can measure integration dynamics, both
before and after the breakpoint. For example, Romania joined
the European Union (EU) in January 2007; the breakpoint
results indicate a signicant increase in integration in February 2007. Whereas few frontier markets exhibit a signicant and constant rate of changing integration, when we
allow for structural breakpoints, we discover signicant
integration dynamics (both increasing and decreasing),
before or after an identied breakpoint, that vary across
countries. The overall results suggest that frontier markets
exhibit low levels of world market integration, even after
allowing for structural breaks. Thus, frontier market risk may
be largely diversiable.
In a mean-variance analysis across market classication
indexes, we nd strong diversication benets exist from
including frontier market equities, especially in the form of
signicant risk reduction. This result is robust both with and
without short-selling constraints, indicating that investors
likely can achieve similar levels of expected return with
lower risk by including frontier market equities. Out-ofsample performance tests and the analysis of ETFs further
conrm these diversication benets.
This study offers three main contributions. First, the
results provide empirical evidence about the level of integration and diversication benets for a complete set of frontier
markets, unlike existing studies that focus on a subset
(e.g., Cheng, Jahan-Parvar, and Rothman, 2009; Jayasuriya
and Shambora, 2009). Although Speidell and Krohne (2007)
examine all potential frontier markets, their analysis is
limited to cross-market correlations. Because this measure
may not be the best indicator of integration, their results are
far from conclusive. Second, structural breakpoint models
identify calendar dates that correspond to shifts in the
integration process and thus extend Pukthuanthong and
Rolls (2009) regressions of world market integration. Third,
analyzing frontier markets provides insights into international diversication with respect to country factors and
geographical diversication, which are relevant topics in
recent literature. For example, Bekaert, Hodrick, and Zhang
(2009) nd that country factors dominate industry factors in
international diversication, and Baele and Inghelbrecht
(2009) show that geographical diversication continues to
offer results superior to those obtained through industry
diversication.
The remainder of this paper is organized as follows. In
the next section, we detail the data and sample. Section 3
presents the market integration analysis and Section 4
analyzes the diversication benets of frontier markets.
We conclude in Section 5.
2. Data
Our study presents an analysis across market classications: namely, developed, emerging, and frontier. We utilize
daily data for the MSCI All Country World Index, which

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

229

Table 1
Country-specic summary statistics and sample period.
This table reports summary statistics covering the country-specic frontier indexes within the sample. First and Last refer to the months in which a
given country enters and exits the sample, while n documents the number of daily return observations. Ri represents the daily return for country i, in
percentage form.
Country
Argentina
Bahrain
Botswana
Bulgaria
Croatia
Estonia
Ghana
Jamaica
Jordan
Kenya
Kuwait
Lebanon
Lithuania
Mauritius
Nigeria
Oman
Pakistan
Romania
Saudi Arabia
Slovenia
Sri Lanka
Trinidad and Tobago
Tunisia
Ukraine
United Arab Emirates

First

Last

Mean(Ri)

Var(Ri)

Min(Ri)

Max(Ri)

08/1993
01/2000
01/1996
11/2000
01/1997
06/1996
01/1996
01/1996
01/1989
02/1990
01/1995
04/2000
01/2000
01/1996
07/1995
11/1996
01/1989
10/1997
01/1998
01/1994
10/1990
01/1996
01/1998
02/1998
06/2005

10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009
10/2009

4037
1435
3127
2286
3205
3392
2816
1289
5197
4638
3807
304
2402
1367
3440
3290
4820
3071
2134
4030
4262
2058
3028
2037
997

0.008
0.047
0.069
0.090
0.038
0.036
 0.048
 0.029
0.029
 0.001
0.038
 0.113
0.063
0.037
0.048
0.034
0.031
 0.001
0.059
0.032
0.019
0.032
0.042
 0.010
 0.063

2.383
0.680
1.505
2.036
1.970
1.813
1.235
2.487
1.195
1.792
1.086
2.100
1.410
1.438
1.263
1.246
1.735
2.113
1.612
1.404
1.142
1.253
0.677
3.159
2.342

 33.650
 7.906
 12.557
 21.504
 13.855
 21.979
 10.186
 23.353
 20.541
 49.330
 24.606
 10.213
 13.475
 8.465
 10.438
 14.832
 12.167
 12.719
 13.488
 11.685
 14.002
 8.224
 6.358
 28.780
 17.273

17.790
3.737
36.756
20.857
16.961
12.385
21.616
36.241
19.965
48.606
25.628
9.536
11.084
16.252
10.274
24.040
12.791
11.592
16.014
11.943
11.875
15.515
4.714
57.904
10.981

includes developed and emerging markets, the MSCI World

Index, which is comprised of developed markets (henceforth,
the MSCI Developed Markets Index), as well as the MSCI
Emerging Markets Index. The sample includes returns to 25
country-specic frontier market indexes. We select frontier
market countries according to the MSCI classication. Data
for Kazakhstan, Serbia, Qatar, and Vietnam are not available,
so these countries are excluded from the sample. Botswana,
Ghana, Jamaica, and Saudi Arabia are included within the
sample, as the addition of these countries to the MSCI
Frontier Markets Index is under consideration. Although per
capita GDP may be relatively high in some countries, the
frontier market classication also considers the level of
development within capital markets, market liquidity, and
investment restrictions. Following Pukthuanthong and Roll
(2009), we choose the total return index for each country,
when available. Finally, all returns and values are denominated in US dollars, based on the Datastream exchange rate
facility.
Daily return data from Datastream are used to create
the frontier market sample. The specic countries
included, as well as dates of coverage are detailed in
Table 1. There are cases in which reliable observations do
not exist for every point within the coverage period;
therefore, Table 1 lists the total number of valid observations for each country in the sample. The frontier market
sample is used to construct equal-weighted and valueweighted frontier market indexes. To provide a lengthy
sample for analysis, the sample begins January 1989, and
countries are added to the sample as data become available. As a result, the frontier indexes consist of a small

number of countries during the early years of the sample.3

However, coverage increases as the sample progresses.
With regard to data issues relating to stale prices raised
by Pukthuanthong and Roll (2009), following their
approach, we eliminate observations for a given country
if the price index does not change. Finally, we eliminate a
small number of frontier market observations by limiting
our sample to only days for which we have observations
for the MSCI World Index.
Constructing the value-weighted index is relatively
difcult and requires a certain degree of estimation. First
of all, market capitalization data are not readily available
for every observation for every country. Further, the
periodicity of market capitalization is longer than that of
the return series. In the cases in which we do not have a
fresh observation of market capitalization, we use the
most recent available observation.4 In some instances
there are no reliable market capitalization data for a
country, nor any reliable lagged observations. In these
cases, the given countrys market capitalization is set
equal to the median level of all frontier market countries
within the sample at that point in time.

3
Subsample analysis, as well as analysis across countries, conrm
that our results are not driven by the early sample in which relatively
few countries enter the index.
4
We use the most recent available market capitalization observation, rather than estimate market capitalization based on subsequent
returns and the previous observation, as this approach would miss any
additions or deletions from the index.

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D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Appendix A provides macro-economic variables for the

frontier market sample. Some countries in the sample are
relatively developed in terms of GDP per capita. For example, in 2008 GDP per capita was $27,019 and $17,454 for
Slovenia and Estonia, respectively. These countries are
included within the frontier market classication because
they are too small to be considered emerging markets.
Slovenias market capitalization was $12.14 billion and
Estonias market capitalization was only $1.70 billion in
2009. In terms of market capitalization, Saudi Arabias
$318.74 billion and the United Arab Emirates (UAE)s
$109.61 billion are higher than the market capitalization
of some emerging markets such as Egypt and Peru. However, these two countries are considered frontier markets
because they have recently become open to international
investors as investment restrictions have loosened. In fact,
all six countries of the Gulf Cooperation Council (Bahrain,
Kuwait, Qatar, Oman, Saudi Arabia, and UAE) are considered
frontier markets.
3. Market integration analysis
3.1. Principal component (PC) analysis
We examine the extent to which frontier markets are
integrated within the global market. Pukthuanthong and Roll
(2009) consider levels of world integration across a broad
sample of developed, emerging, and frontier countries. Specically, they regress daily country index returns on their
global PCs. To apply their methodology to frontier market
countries, as well as broad frontier market indexes, we obtain
the PC data up until 2007 from Pukthuanthong and Roll and
construct PCs for 2008 and 2009. Table 2 presents results for
the MSCI World Index, which represents developed markets,
the MSCI Emerging Markets Index, and the broad frontier
market indexes. With this approach, the adjusted R-square
measures the proportion of an indexs return that is
explained by global factors, while the coefcient on the rst
PC is comparable to the loading on a global market factor. As
the PCs are mutually orthogonal, interpretation of the
remaining coefcient estimates is not straightforward and
consequently the remaining parameter estimates are not
reported. Results from the principal component regressions
are presented in columns 2 and 3 of Table 2. To provide a
comparison across the PC approach and standard correlations
as a measure of integration, Table 2 also reports cross-index
correlations and associated p-values, in the nal four columns
of the table. Panel A presents results from the full sample,
while the remaining panels present subsample analyses, with
sample periods denoted in the panel headings.
Results in Table 2 show a striking lack of world market
integration across the frontier indexes, despite high levels of
integration for the developed and emerging market indexes.
In Panel A, the adjusted R-square from the PC regressions are
 0.0003 and 0.0049 for the frontier value-weighted and
equal-weighted indexes, respectively. The corresponding
values are 0.4399 and 0.6244 for the emerging market and
developed market indexes, respectively. The adjusted
R-square measures indicate that the PCs explain very little
of the variation in frontier market returns, despite the
evidence that they explain a large portion of emerging and

developed market return variation. Coefcients for the global

market factor are large in magnitude and highly signicant
based on the emerging and developed market indexes.
However, the coefcient estimate for the value-weighted
frontier index is insignicant. While the global market factor
parameter estimate is signicant based on the equalweighted frontier index, it is small in magnitude. Comparable
parameter estimates for the developed and emerging market
indexes are both over 20 times larger in magnitude. In short,
the developed and emerging market indexes exhibit high
levels of world market integration, while the evidence
suggests frontier markets are not integrated.
Pukthuanthong and Roll (2009) argue that the PC
approach provides a better analysis of world market integration, relative to the common correlation approach. Carrieri,
Errunza, and Hogan (2007) also discuss the drawbacks from
using cross-market correlations as a measure of integration.
The nal four columns in Table 2 show comparable results
and inference across the PC measure and the correlation
approach with respect to the level of developed and emerging market integration. Both PC regressions and correlation
results suggest that developed and emerging markets exhibit
a high degree of world market integration. Further, with
respect to levels of integration throughout the sample, both
the PC approach and correlations indicate a small degree of
integration for frontier markets. For example, the coefcient
estimate on the rst PC is insignicant for the valueweighted index, and the correlation between the valueweighted index and the world market, although signicant,
is only 0.04. The PC results show a positive and signicant
coefcient on the rst PC for the frontier equal-weighted
index; however, the coefcient of 0.08 is small in magnitude.
The correlation across the equal-weighted frontier index and
the all country index of 0.06 also indicates some level of
positive, but marginal integration. We believe the magnitude
of integration is likely best described by the PC results, as
explained by Pukthuanthong and Roll (2009).
The broad frontier indexes include data from each frontier
market when data become available. Consequently, coverage
of the indexes is thin during the early sample periods.
Subsample results provide analyses in early years, as well
as during more recent periods, which include many frontier
equity markets. For example, 20 of the 25 frontier market
countries are included within the broad indexes by January
2000. Results in Panel C of Table 2, covering the 10 years
from January 2000 through October 2009, conrm the
analysis based on the entire sample discussed above. Specically, both broad frontier market indexes exhibit small or
insignicant parameter estimates for the world factor. In
addition, adjusted R-square measures are very close to zero.
These results contrast the large and signicant world market
factor coefcients, as well as large adjusted R-square measures for the developed and emerging market indexes.
Finally, Panels D through G contain subperiod results across
approximate 5-year periods. Panel H contains results from
the nal 2 years of the sample period to measure any
changes in the global market during the subprime mortgage
crisis, which represents a very unique sample. The results in
Panels D through G conrm the discussion above, in that the
PC results indicate little integration across frontier market
indexes with the world market.

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

231

Table 2
PC results and correlations across market classication indexes.
This table reports measures of world market integration. Entries under the PC1 and Adjusted R2 headings correspond to the coefcient estimate on the
rst principal component, along with the associated p-value, and the adjusted R-square from the Pukthuanthong and Roll (2009) principal component
approach, which regresses index returns on 10 global factors. The nal four columns report cross-index correlations of daily returns and associated
p-values for the given indexes. Subsamples are denoted in each panel.
Index

Panel A: 19892009
MSCI Developed
MSCI Emerging
Value-weighted frontier index
Equal-weighted frontier index
Panel B: Subsample 1 (19891999)
MSCI Developed
MSCI Emerging
Value-weighted frontier index
Equal-weighted frontier index
Panel C: Subsample 2 (20002009)
MSCI Developed
MSCI Emerging
Value-weighted frontier index
Equal-weighted frontier index

PC1

Adjusted R2

MSCI All Country

MSCI Developed

MSCI Emerging

1.6962
(0.000)
1.8900
(0.000)
0.0327
(0.532)
0.0802
(0.008)

0.6244

0.9824
(0.000)
0.6310
(0.000)
0.0381
(0.005)
0.0569
(0.001)

0.5967
(0.000)
0.0417
(0.002)
0.0573
(0.000)

0.0507
(0.000)
0.1008
(0.000)

0.6732
(0.000)

0.9764
(0.000)
0.5017
(0.000)
0.0047
(0.804)
0.0212
(0.259)

0.4716
(0.000)
0.0110
(0.557)
0.0256
(0.174)

 0.0171
(0.364)
0.0116
(0.536)

0.7184
(0.000)

0.9854
(0.000)
0.7063
(0.000)
0.0679
(0.001)
0.0889
(0.000)

0.6682
(0.000)
0.0688
(0.001)
0.0860
(0.000)

0.1159
(0.000)
0.1840
(0.000)

0.6152
(0.000)

0.9570
(0.000)
0.3896
(0.000)
0.0178
(0.524)
0.0130
(0.640)

0.3787
(0.000)
0.0295
(0.291)
0.0205
(0.464)

 0.0283
(0.311)
 0.0274
(0.327)

0.8421
(0.000)

0.9964
(0.000)
0.6226
(0.000)
 0.0115
(0.679)
0.0358
(0.199)

0.5684
(0.000)
 0.0084
(0.762)
0.0366
(0.189)

 0.0204
(0.464)
0.0514
(0.065)

0.6231
(0.000)

0.9979
(0.000)
0.5426
(0.000)
0.0556
(0.046)
0.0445
(0.110)

0.5094
(0.000)
0.0526
(0.058)
0.0408
(0.143)

0.0616
(0.027)
0.0932
(0.001)

0.3948
(0.000)

0.9902
(0.000)
0.7411
(0.000)
 0.0279
(0.369)

0.6769
(0.000)
 0.0223
(0.474)

 0.0640
(0.039)

1.5540
(0.000)
1.8100
(0.000)
0.0089
(0.908)
0.0768
(0.137)
1.7288
(0.000)
1.8534
(0.000)
0.0459
(0.512)
0.0944
(0.013)

Panel D: Subsample 3 (19891993)

MSCI Developed
1.5150
(0.000)
MSCI Emerging
1.3820
(0.000)
Value-weighted frontier index
0.0674
(0.553)
Equal-weighted frontier index
0.1220
(0.203)
Panel E: Subsample 4 (19941998)
MSCI Developed
MSCI Emerging
Value-weighted frontier index
Equal-weighted frontier index
Panel F: Subsample 5 (19992003)
MSCI Developed
MSCI Emerging
Value-weighted frontier index
Equal-weighted frontier index

1.5770
(0.000)
2.1310
(0.000)
0.0017
(0.990)
0.0470
(0.485)
2.1180
(0.000)
1.9220
(0.000)
0.1740
(0.048)
0.0601
(0.152)

Panel G: Subsample 6 (20042007)

MSCI Developed
1.6070
(0.000)
MSCI Emerging
2.5980
(0.000)
Value-weighted frontier index
 0.1410
(0.316)

0.4399
 0.0003
0.0049

0.5578
0.2993
 0.0013
0.0072

0.7449
0.5515
0.0004
0.0000

0.6332
0.1994
0.0036
0.0136

0.7099
0.4243
 0.0068
0.0014

0.6594
0.4353
0.0040
 0.0023

0.7317
0.7182
0.0101

Value-weighted
frontier index

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D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Table 2 (continued )
Index

Equal-weighted frontier index

PC1

Adjusted R2

MSCI All Country

MSCI Developed

MSCI Emerging

Value-weighted
frontier index

0.0821
(0.063)

0.0090

0.0680
(0.028)

0.0634
(0.041)

0.0464
(0.135)

0.4141
(0.000)

0.7664

0.9970
(0.000)
0.8236
(0.000)
0.4815
(0.000)
0.5506
(0.000)

0.7774
(0.000)
0.4472
(0.000)
0.5135
(0.000)

0.6370
(0.000)
0.7152
(0.000)

0.9021
(0.000)

Panel H: Subsample 7 (20082009)

MSCI Developed
1.7208
(0.000)
MSCI Emerging
2.6112
(0.000)
Value-weighted frontier index
 0.1006
(0.228)
Equal-weighted frontier index
0.0865
(0.049)

0.7303
0.0211
0.0104

With the exception of the nal 2 years of our sample,

overall the correlation results are consistent with the PC
results, and suggest little integration across the broad
frontier indexes with the world market. Correlations
across the frontier indexes and the all country, developed,
and emerging market indexes are all less than 0.1 in
Panels B through G, with the exception of the 20002009
subsample presented in Panel C, in which the correlation
between frontier market indexes and emerging markets is
marginally greater than 0.1. However, correlations presented in Panel H for the 20082009 subsample are large
in magnitude. Correlations with the all country index are
0.48 and 0.55 for the value-weighted and equal-weighted
frontier indexes, respectively. This result is consistent
with Ang and Bekaert (2002) and Longin and Solnik
(2001), who nd that correlations tend to increase during
bear markets. Further, Forbes and Rigobon (2002) show
that correlations are biased upwards given heteroskedasticity and periods of increasing volatility.
Results in Table 2 analyze integration of broad frontier
market indexes and provide a measure of integration
across market classications. The results indicate that
the countries contained within the frontier classication
appear largely segragated from world capital markets. To
expand this analysis, we present similar results across
country-specic frontier market indexes in Table 3.
The country-specic analysis nds very little evidence
of frontier market integration. The parameter estimate on
the rst PC is less than 0.002 for each of the 25 frontier
countries. Comparable estimates from Table 2 equal 1.70
for the developed markets index, and 1.89 for the emerging markets index. The adjusted R-square measure from
the PC analysis is greater than 0.05 for only four countries,
Argentina, Croatia, Estonia, and Lithuania, and in these
cases, still less than 0.10. For comparison, the adjusted Rsquares are 0.62 for the developed markets index, and
0.44 for the emerging markets index.
Daily return correlations in Table 3 provide little
evidence of high integration across frontier and developed
markets.5 No frontier country exhibits a correlation with

5
Daily correlations may be small, even across active developed
markets, as information is released during a calendar day after easterly

the world or developed markets index that is greater than

0.3, and only ve countries exhibit correlations in excess
of 0.2. Although 13 of the 25 frontier countries exhibit
correlations that are greater than 0.1, the overall conclusion based on the correlation approach is that frontier
market countries tend to exhibit a low level of world
market integration, consistent with the PC results.
3.2. Time-varying integration
Levels of world market integration likely vary through
time. For example, Carrieri, Errunza, and Hogan (2007)
indicate that world market integration tends to increase.
However, they also nd reversals in levels of integration. Bekaert, Harvey, and Lumsdaine (2002) estimate structural break models to identify periods of segmentation and
integration. They discuss that integration may be a gradual
process and often occurs after dates of ofcial liberalization.
To consider trends within the level of frontier market
integration, we follow Pukthuanthong and Roll (2009) and
regress the adjusted R-square from the PC analysis on a
simple time-trend. Initially, we estimate the PC model based
on subsequent 6-month calendar periods from January 1989
through October 2009, and then regress the adjusted Rsquare measure from each 6-month regression on a timetrend. Results are reported in Panel A of Table 4. The
remaining panels detail results based on bimonthly R-square
regressions. To compare results across the PC and correlation
approaches, columns 3 and 4 contain results from regressing
correlations computed across the given index and the all
country world index from either 6-month or 2-month intervals, as indicated in the panel heading, on a simple timetrend, in the same fashion as the PC approach.
The time-trend parameter estimates in Panel A
of Table 4 are positive and highly signicant for the
developed and emerging market indexes, while corresponding estimates are insignicant based on the frontier
market indexes. Emerging and developed markets exhibit
(footnote continued)
markets have closed, and consequently incorporated in these markets on
the following day. However, our broad frontier indexes mitigate this
concern somewhat, as the broad frontier market indexes span multiple
time zones. We thank the referee for this explanation.

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

233

Table 3
PC results and correlations across country-specic indexes.
Entries within the rst four columns of the table represent the correlation of daily returns and the associated p-value for the given country and market
classication index. Entries within the nal two columns correspond to the coefcient on the rst principal component, PC1, along with associated
p-value, and adjusted R-square from the Pukthuanthong and Roll (2009) principal component approach, which regresses index returns on 10 global
factors. The sample period is from 1989 to 2009.

Argentina
Bahrain
Botswana
Bulgaria
Croatia
Estonia
Ghana
Jamaica
Jordan
Kenya
Kuwait
Lebanon
Lithuania
Mauritius
Nigeria
Oman
Pakistan
Romania
Saudi Arabia
Slovenia
Sri Lanka
Trinidad and Tobago
Tunisia
Ukraine
United Arab Emirates

MSCI all countries

MSCI developed

MSCI emerging

Frontier value-weighted

PC1

Adjusted R2

0.1689
(0.000)
0.0159
(0.548)
0.1144
(0.000)
0.1593
(0.000)
0.2759
(0.000)
0.1381
(0.000)
0.0160
(0.396)
0.0470
(0.092)
0.0505
(0.000)
0.0273
(0.063)
0.0633
(0.000)
0.2650
(0.000)
0.2533
(0.000)
0.0997
(0.000)
 0.0084
(0.623)
0.0888
(0.000)
0.0260
(0.071)
0.2447
(0.000)
0.1030
(0.000)
0.1813
(0.000)
0.0413
(0.007)
0.0015
(0.947)
0.1507
(0.000)
0.1118
(0.000)
0.2496
(0.000)

0.1655
(0.000)
0.0006
(0.981)
0.1025
(0.000)
0.1442
(0.000)
0.2602
(0.000)
0.1295
(0.000)
0.0183
(0.333)
0.0415
(0.136)
0.0468
(0.001)
0.0217
(0.140)
0.0572
(0.000)
0.2443
(0.000)
0.2314
(0.000)
0.0819
(0.002)
 0.0076
(0.655)
0.0786
(0.000)
0.0281
(0.052)
0.2283
(0.000)
0.0936
(0.000)
0.1678
(0.000)
0.0381
(0.013)
0.0026
(0.907)
0.1412
(0.000)
0.0952
(0.000)
0.2256
(0.000)

0.1396
(0.000)
0.0866
(0.001)
0.1710
(0.000)
0.2152
(0.000)
0.2678
(0.000)
0.1604
(0.000)
0.0098
(0.602)
0.0603
(0.030)
0.0691
(0.000)
0.0486
(0.001)
0.0897
(0.000)
0.3563
(0.000)
0.2957
(0.000)
0.1380
(0.000)
0.0005
(0.978)
0.1656
(0.000)
0.0457
(0.002)
0.2721
(0.000)
0.1192
(0.000)
0.2012
(0.000)
0.0737
(0.000)
0.0053
(0.810)
0.1563
(0.000)
0.1450
(0.000)
0.3526
(0.000)

0.2554
(0.000)
0.0719
(0.007)
0.0336
(0.060)
0.1894
(0.000)
0.1953
(0.000)
0.1673
(0.000)
0.0501
(0.008)
0.0354
(0.204)
0.1735
(0.000)
0.0553
(0.000)
0.1122
(0.000)
0.1252
(0.029)
0.1876
(0.000)
0.0406
(0.134)
0.0267
(0.117)
0.0846
(0.000)
0.2948
(0.000)
0.1460
(0.000)
0.4200
(0.000)
0.6366
(0.000)
0.0492
(0.001)
 0.0007
(0.976)
0.2580
(0.000)
0.1043
(0.000)
0.1659
(0.000)

0.0017
(0.000)
0.0001
(0.082)
0.0004
(0.000)
0.0007
(0.000)
0.0015
(0.000)
0.0011
(0.000)
0.0001
(0.198)
0.0000
(0.577)
0.0003
(0.000)
0.0001
(0.202)
0.0000
(0.319)
0.0001
(0.205)
0.0008
(0.000)
0.0001
(0.013)
0.0008
(0.027)
0.0000
(0.822)
0.0003
(0.001)
0.0006
(0.000)
0.0000
(0.722)
0.0005
(0.000)
0.0001
(0.014)
0.0001
(0.096)
0.0003
(0.000)
0.0001
(0.600)
0.0002
(0.465)

0.0603

increasing world market integration, but no such trend

exists within frontier markets. Interestingly, the PC
approach is able to capture changing levels of integration
that are not captured by the simple correlation approach.
For example, across the entire sample period, the PC
approach indicates that developed markets become
increasingly integrated, while the corresponding estimate
based on correlations is insignicant. The results in this
section further compliment the earlier ndings in that not
only do frontier markets exhibit low levels of overall

0.0003
0.0232
0.0284
0.0837
0.0780
0.0047
0.0014
0.0092
0.0005
0.0024
 0.0017
0.0594
0.0001
0.0005
 0.0018
0.0053
0.0260
 0.0006
0.0270
 0.0001
0.0016
0.0261
0.0127
0.0047

integration, but these levels do not appear to increase

through time.
The bimonthly regression subsample analyses presented in Panels B through H also show several interesting
results. First, the time-trend is signicant and positive
based on the equal-weighted frontier index during the
1994 through 1998 sample period presented in Panel F.
However, no other subsample provides signicant
estimates for either frontier markets index. Further, in
unreported results based on monthly regressions, the time-

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D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Table 4
Integration through time across market classication indexes.
This table presents results from regressing calendar-period integration measures on a time-trend variable. Entries under the PC and Correlation
headings present results using the R-square from the Pukthuanthong and Roll (2009) principal component approach, and the correlation of daily returns
for the given index with the MSCI All Country World Index, respectively, as the measure of calendar-period integration. The calendar-period integration
measures are formed with 6-month periods in Panel A, and with 2-month periods in the remaining panels. Entries under the Time heading present
parameter estimates for the time-trend variable and the associated p-value, while entries under the Adjusted R2 heading represent the adjusted R-square
from the regression of the calendar-period integration measure on time. Subsample periods are denoted in the panel headings.
PC
Index

Time

Panel A: 19892009 Sample with six-month regressions

MSCI Developed
2.16n10  3
(0.003)
MSCI Emerging
1.78n10  2
(0.000)
Value-weighted frontier index
 3.71n10  4
(0.395)
Equal-weighted frontier index
 7.08n10  5
(0.967)
Panel B: 19892009 Sample with bimonthly regressions
MSCI Developed
6.64n10  4
(0.010)
MSCI Emerging
6.72n10  3
(0.000)
Value-weighted frontier index
 8.14n10  5
(0.763)
Equal-weighted frontier index
 3.05n10  4
(0.577)
Panel C: Bimonthly regressions with subsample 1 (19891999)
MSCI Developed
1.23n10  3
(0.010)
MSCI Emerging
5.08n10  3
(0.005)
Value-weighted frontier index
 7.59n10  4
(0.516)
Equal-weighted frontier index
5.96n10  4
(0.612)
Panel D: Bimonthly regressions with subsample 2 (20002009)
MSCI Developed
 3.49n10  4
(0.707)
MSCI Emerging
5.86n10  3
(0.000)
Value-weighted frontier index
 1.31n10  3
(0.295)
Equal-weighted frontier index
1.60n10  4
(0.993)
Panel E: Bimonthly regressions with subsample 3 (19891993)
MSCI Developed
2.94n10  3
(0.154)
MSCI Emerging
 1.07n10  3
(0.854)
Value-weighted frontier index
 8.86n10  4
(0.852)
Equal-weighted frontier index
 1.74n10  3
(0.661)
Panel F: Bimonthly regressions with subsample 4 (19941998)
MSCI Developed
3.53n10  3
(0.003)
MSCI Emerging
1.51n10  2
(0.004)
Value-weighted frontier index
6.34n10  4
(0.847)
Equal-weighted frontier index
6.41n10  3
(0.021)
Panel G: Bimonthly regressions with subsample 5 (19992003)
MSCI Developed
1.86n10  3
(0.011)
MSCI Emerging
9.97n10  3

Correlation
2

Adjusted R

Time

Adjusted R2

0.2183

 9.86n10  6
(0.984)
1.17n10  2
(0.000)
3.79n10  3
(0.039)
4.87n10  3
(0.006)

 0.0250

 1.02n10  4
(0.263)
3.96n10  3
(0.000)
1.02n10  3
(0.018)
1.27n10  3
(0.007)

0.0021

0.6423
0.0003
 0.0251

0.0512
0.4734
 0.0082
 0.0063

0.0599
0.1142
 0.0071
 0.0110

 0.0156
0.3642
 0.0019
 0.0236

0.0544
 0.0345
 0.0337
 0.0274

0.0844
0.2392
 0.0341
0.0720

0.1203
0.2605

3.81n10  4
(0.118)
5.53n10  3
(0.001)
1.82n10  4
(0.866)
9.29n10  4
(0.395)

0.4799
0.0801
0.1525

0.3573
0.0369
0.0510

0.0228
0.1591
 0.0152
 0.0041

 8.38n10  4
(0.002)
5.03n10  3
(0.000)
2.99n10  3
(0.031)
4.62n10  3
(0.003)

0.1471

1.25n10  3
(0.290)
1.17n10  3
(0.843)
4.36n10  3
(0.240)
4.27n10  3
(0.233)

0.0057

4.51n10  4
(0.006)
8.81n10  3
(0.034)
3.12n10  3
(0.373)
7.03n10  3
(0.043)
 1.25n10  4
(0.086)
 1.38n10  3

0.3264
0.0630
0.1283

 0.0342
0.0151
0.0165

0.2117
0.1204
 0.0062
0.1082

0.0693
 0.0290

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

235

Table 4 (continued )
PC
Index

Value-weighted frontier index

Equal-weighted frontier index

Time
(0.002)
3.06n10  4
(0.934)
5.41n10  4
(0.818)

Panel H: Bimonthly regressions with subsample 6 (20042009)

MSCI Developed
6.63n10  4
(0.625)
MSCI Emerging
1.75n10  2
(0.000)
Value-weighted frontier index
 1.39n10  4
(0.911)
Equal-weighted frontier index
 5.30n10  3
(0.485)

trend coefcient for the value-weighted frontier markets

index is negative and marginally signicant during the years
from 1989 through 1999. Overall, the time-trend and subsample analyses show that frontier market integration is not
increasing. Table 4 also shows subsamples in which the MSCI
Developed Markets Index does not exhibit a positive trend in
integration, consistent with the time-varying world market
integration shown by Bekaert and Harvey (1995). Specically,
the time-trend coefcient for the MSCI Developed Markets
Index is insignicant based on the 2000 through 2009
sample, presented in Panel D, as well as in the shorter
subsamples from 1989 through 1993 and 2004 through
2009, presented in Panels E and H, respectively. Finally, in
most cases the PC results are similar to the correlation
results, with respect to frontier markets. Both approaches
fail to nd a signicant increase or decrease in world market
integration within frontier market indexes during most
samples. However, results in Table 2 indicate strong increases
in correlations between frontier indexes and the world index
during 2008 and 2009. The PC approach does not show a
similar pattern. From Table 4, results tend to differ across PC
and correlation regressions when the sample includes 2008
and 2009. That is, in those cases correlations tend to increase,
while the adjusted R-squares from the PC regressions do not.
This result suggests the correlation approach is heavily
inuenced by the extreme observations during the latter
sample period.
Fig. 1 plots R-square measures from 6-month regressions through time, to detail levels of integration across
market classications. The gure shows that the level of
integration for both frontier market indexes remains
essentially at and approximately equals zero, which
suggests a constant and low level of frontier market
integration throughout the entire sample period. The
gure also shows a dramatic time-trend in terms of
emerging market integration beginning during the early
1990s. Finally, the level of developed market integration
appears high and almost constant throughout the sample.
This result helps explain the lack of a time-trend for
developed markets shown in the latter subsamples presented in Table 4.

Correlation
2

Adjusted R

 0.0353
 0.0340

 0.0443
0.4031
 0.0442
 0.0130

Time
(0.673)
2.48n10  3
(0.396)
4.76n10  4
(0.893)
 1.57n10  3
(0.034)
5.50n10  3
(0.003)
1.01n10  2
(0.003)
1.17n10  2
(0.002)

Adjusted R2

 0.0089
 0.0350

0.1033
0.2210
0.2173
0.2369

3.3. Country-specic integration and structural break test

To understand country-specic integration through
time, we regress the adjusted R-squares from the PC
analysis on a linear time-trend for each individual country. Table 5 reports parameter estimates of the constant
and time-trend from these regressions. Out of the 25
countries, 10 have positive time-trend coefcients, while
15 have negative estimates. However, only three of these
estimates are signicant at the 5% level. Estonia exhibits
increasing integration through time, while integration
decreases within Jamaica and Jordan. Considering the
estimate of the constant term, Botswana, Ghana, Jamaica,
Trinidad and Tobago, Tunisia, and Ukraine all exhibit
estimates above 0.3. Therefore, even though the trend is
not increasing, these countries exhibit some level of
positive world market integration.
The time-trend regressions presented in Table 5 allow
integration to change through time. However, this
approach ts a constant rate of change throughout the
sample for a given country. We extend this model to allow
for structural breaks in the level of integration, captured
by changes in the constant term in the regression, as well
as changes in the rate of integration, captured by changes
in the time-trend parameter. World market integration
dynamics could vary during certain periods, or exhibit
structural breaks, due to changes in regulations, such as
investment restrictions or the formation of economic
unions like the EU. Quandt-Andrews Breakpoint test
identies unknown structural breakpoints in the timetrend regressions. Tests are conducted separately for a
joint breakpoint in the constant and time-trend, breakpoints in the time-trend only, and the constant term only.
We report identied breakpoints and the associated pvalues from each breakpoint test in the nal three
columns of Table 5. Based on the 10% signicance level,
integration dynamics within 14 countries exhibit signicant structural breaks for at least one of the breakpoint
tests. In most cases, the three breakpoint tests identify the
same calendar month for a given country. European
countries such as Bulgaria, Romania, and Slovenia have

236

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

0.6
ERET
WRET
FIE
FIV

0.4

Jun-08

Jun-09

Jun-07

Jun-06

Jun-05

Jun-04

Jun-03

Jun-02

Jun-01

Jun-00

Jun-99

Jun-98

Jun-97

Jun-96

Jun-95

Jun-94

Jun-93

Jun-92

-0.2

Jun-91

Jun-90

0.2

Jun-89

Adjusted R-squares

0.8

-0.4
Fig. 1. Global market integration from January 1989 to October 2009. The gure plots adjusted R-squares from the Pukthuanthong and Roll (2009)
principal component approach in which returns to a market classication index are regressed on 10 global factors. Regressions are based on 6-month
calendar periods. FIV is value-weighted frontier index; FIE is equal-weighted frontier index; ERET is MSCI Emerging Markets index; and WRET is MSCI
World Index representing developed markets.

structural breakpoints around the end of 2006 to early

2007. Interestingly, joining the EU does not necessarily
lead to greater integration. Although both Lithuania and
Slovenia joined the EU in 2004, Lithuanias structural
breakpoint in November 2004 is not signicant. African
countries such as Botswana, Ghana, and Trinidad and
Tobago exhibit structural breakpoints from 1999 to
2001. Argentina has a breakpoint in 2005, while Saudi
Arabias breakpoint was in 1998.
Augmenting the regression of adjusted R-square on
time with breakpoint dummy-variables provides estimates of world market integration dynamics. Specically,
for each country, we separately dene a variable, breakt
that takes the value of zero for all observations prior to
the identied breakpoint and the value of one for all
subsequent observations. This approach creates the following models in which, both the constant and timetrend change (Eq. (1)), the time-trend changes (Eq. (2)),
and the constant changes (Eq. (3)):
adjR2t a0 a1 breakt b0 t b1 tbreakt et ,

adjR2t a0 b0 t b1 tbreakt et ,

adjR2t a0 a1 breakt b0 t et :

adjR2t

The variable
represents the adjusted R-square
from the PC model during month t, while t is an ordinal
time-trend variable. For simplicity, parameter notation is
maintained across the three models. Table 6 reports
results from the appropriate structural break model for
countries in which the Quandt-Andrews Breakpoint test
results, presented in Table 5, indicate a signicant breakpoint at the 10% level.

Results in Table 6 detail signicant dynamics with

respect to world market integration that are not apparent
in analyses of the entire sample period. Results from the
Quandt-Andrews Breakpoint test in Table 5 indicate a
signicant break in both the constant and time-trend for
Slovenia in October 2006. Results that include dummyvariable terms for both the constant and the time-trend
are presented in Panel A of Table 6. The b0 parameter
estimate of 0.0033 indicates increasing integration for
Slovenia until the identied breakpoint. Following the
breakpoint, the parameter estimate of b1 is  0.0361. As
b1 represents the shift in the slope following the breakpoint, the sum of the two parameters, b0 and b1, indicates
that the overall rate of integration following the breakpoint is approximately 0.03. Finally, the parameter
estimate of a1 indicates a signicant positive shift in the
level of integration following the breakpoint. As a whole,
the results for Slovenia in Panel A indicate increasing
integration until October 2006, at which point the level of
integration shifts and the rate of integration decreases.
Panel B of Table 6 details results from Eq. (2) for
countries with signicant breakpoints in the time-trend
parameter. Both Argentina and Romania exhibit insignificant rates of integration prior to their breakpoints.
However, the b1 parameter estimates of 0.0023 and
0.0039 for Argentina and Romania, respectively, indicate
increasing integration subsequent to the breakpoint. b0
parameter estimates for Botswana, Bulgaria, Croatia,
Ghana, Saudi Arabia, Slovenia, Trinidad and Tobago, and
Ukraine are positive, while estimates of b1 are negative
and approximately equal in magnitude to b0. Therefore,
these countries exhibit increasing integration throughout
the early sample, followed by no increasing or decreasing
integration subsequent to the breakpoint, as the sum of

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

237

Table 5
Frontier market country integration through time.
This table shows frontier market integration through time. Entries under the Constant and Trend headings present parameter estimates along with
associated p-values for the intercept and time-trend, respectively, from regressing monthly adjusted R-squares based on the Pukthuanthong and Roll
(2009) principal component approach on a linear time-trend. Entries under the Structural break tests heading present identied breakpoints and
associated p-values from structural break tests for a changing constant and time-trend, changing time-trend, and changing constant, respectively, based
on the Quandt-Andrews Breakpoint test. ***, **, and * indicate signicance at the 1%, 5%, and 10% levels, respectively.
Adjusted R-squares

Structural break tests

Country

Constant

Trend

Constant and trend

Trend only

Constant only

Argentina

0.1328
(0.033)
0.0440
(0.596)
0.4037
(0.000)
0.0037
(0.969)
0.0302
(0.643)
0.0697
(0.175)
0.3274
(0.000)
0.4045
(0.000)
0.1794
(0.001)
0.0536
(0.476)
0.0695
(0.262)
0.0017
(0.992)
0.0612
(0.415)
 0.0817
(0.226)
 0.0127
(0.849)
0.1003
(0.165)
0.1155
(0.087)
0.0125
(0.858)
0.0422
(0.576)
0.0784
(0.145)
0.1997
(0.000)
0.3446
(0.000)
0.3230
(0.000)
0.3138
(0.000)
0.0149
(0.909)

0.0010
(0.232)
0.0002
(0.992)
 0.0012
(0.926)
0.0019
(0.290)
0.0017
(0.350)
0.0026
(0.004)
 0.0032
(0.202)
 0.0034
(0.023)
 0.0010
(0.001)
 0.0007
(0.373)
 0.0011
(0.099)
 0.0006
(0.840)
0.0028
(0.074)
0.0008
(0.257)
 0.0003
(0.209)
 0.0006
(0.116)
 0.0009
(0.498)
0.0018
(0.103)
 0.0002
(0.403)
0.0018
(0.056)
 0.0014
(0.659)
 0.0030
(0.587)
 0.0007
(0.657)
 0.0029
(0.272)
0.0012
(0.449)

10/2002
(0.302)
7/2001
(0.844)
1/2001
(0.241)
4/2004
(0.337)
1/2004
(0.699)
3/2004
(0.912)
1/1999
(0.124)
1/2001
(0.436)
1/2007
(0.526)
3/2004
(0.748)
4/2007
(0.811)
7/2001
(0.974)
7/2007
(0.878)
5/2003
(0.964)
3/2001
(0.927)
6/1997
(0.942)
7/1995
(0.843)
11/2006
(0.539)
12/1998
(0.750)
8/2006**
(0.040)
4/1996
(0.725)
12/2000
(0.423)
7/2002
(0.414)
1/2001
(0.585)
2/2007
(0.977)

10/2005**
(0.017)
7/2001
(0.475)
1/2001***
(0.002)
12/2006**
(0.031)
10/2005*
(0.064)
3/2004
(0.970)
1/1999***
(0.000)
1/2001*
(0.058)
6/2000
(0.181)
3/2004*
(0.071)
8/2003
(0.663)
11/2006
(0.357)
11/2004
(0.394)
5/2003
(0.522)
3/2001
(0.556)
5/2000
(0.944)
4/2003
(0.238)
2/2007**
(0.013)
12/1998**
(0.034)
10/2006***
(0.000)
4/1996*
(0.088)
12/2000***
(0.005)
7/2002**
(0.013)
1/2001**
(0.025)
2/2007
(0.312)

10/2005**
(0.017)
7/2001
(0.596)
1/2001***
(0.001)
10/2003**
(0.021)
10/2005*
(0.074)
3/2004
(0.372)
1/1999***
(0.001)
1/2001**
(0.013)
12/2006
(0.179)
3/2004*
(0.059)
8/2003
(0.507)
11/2006
(0.349)
11/2004
(0.411)
5/2003
(0.305)
3/2001
(0.813)
4/2005
(0.913)
7/1995*
(0.067)
2/2007**
(0.014)
12/1998**
(0.023)
10/2006***
(0.000)
9/1996
(0.197)
12/2000**
(0.013)
7/2002**
(0.021)
1/2001**
(0.021)
2/2007
(0.304)

Bahrain
Botswana
Bulgaria
Croatia
Estonia
Ghana
Jamaica
Jordan
Kenya
Kuwait
Lebanon
Lithuania
Mauritius
Nigeria
Oman
Pakistan
Romania
Saudi Arabia
Slovenia
Sri Lanka
Trinidad and Tobago
Tunisia
Ukraine
United Arab Emirates

the two parameters, b0 and b1, is approximately zero for

each country. Finally, Kenya, Sri Lanka, and Tunisia
indicate some level of decreasing integration prior to the
breakpoint, followed by no subsequent change in
integration.
The intercept in the time-trend regressions indicates
levels of integration, rather than rates of change which are

captured by the time-trend parameter. Therefore, changes

in the constant term indicate shifts in the overall level of
integration that occur relatively quickly with respect to
time. Results in Panel C of Table 6 indicate positive shifts
in integration following the breakpoints for Argentina,
Bulgaria, Kenya, Romania, and Tunisia. For example, considering Romania, parameter estimates of a0, a1, and b0

238

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Table 6
Structural break models of world market integration.
The table presents structural break regression results from the model:
adjR2t

a0 a1 breakt b0 t b1 tbreakt et ,

Trinidad and Tobago

in which adjR2t represents the adjusted R-square from the Pukthuanthong

and Roll (2009) principal component approach during month t, t is an
ordinal time-trend variable, and breakt is a dummy variable taking the value
of zero for all observations prior to the identied breakpoint, and taking the
value of one otherwise. Quandt-Andrews Breakpoint test identies signicant breakpoints for each country. Panels AC present parameter estimates
for countries with an identied breakpoint in the constant and time-trend,
the time-trend only, and the constant only, respectively. Table entries
correspond to the given parameter estimate and its associated p-value.

a0

a1

Panel A: Breakpoint in constant and time-trend

Slovenia
 0.0030
5.3198
(0.955)
(0.039)
Panel B: Breakpoint in time-trend
Argentina
0.2226
(0.001)
Botswana
0.2064
(0.018)
Bulgaria
 0.1186
(0.221)
Croatia
 0.0641
(0.366)
Ghana
0.0657
(0.479)
Jamaica
0.2607
(0.007)
Kenya
0.1692
(0.044)
Romania
0.0852
(0.222)
Saudi Arabia
 0.0734
(0.384)
Slovenia
0.0015
(0.977)
Sri Lanka
0.3300
(0.000)
Trinidad and Tobago
0.1259
(0.168)
Tunisia
0.5164
(0.000)
Ukraine
0.1318
(0.250)
Panel C: Breakpoint in constant
Argentina
0.2216
(0.001)
Botswana
0.3247
(0.000)
Bulgaria
0.0705
(0.436)
Croatia
 0.0624
(0.377)
Ghana
0.4212
(0.000)
Jamaica
0.3291
(0.000)
Kenya
0.1677
(0.045)
Pakistan
0.1042
(0.116)
Romania
0.0849
(0.224)
Saudi Arabia
0.3420
(0.005)
Slovenia
0.0025
(0.962)

0.3692
(0.001)
 0.5113
(0.000)
0.5643
(0.001)
 0.3240
(0.003)
 0.5169
(0.000)
 0.4680
(0.001)
0.3893
(0.003)
 0.3821
(0.003)
0.4630
(0.001)
 0.4584
(0.002)
 0.4879
(0.000)

Table 6 (continued )

b0

b1

0.0033
(0.000)

 0.0361
(0.025)

 0.0008
(0.331)
0.0069
(0.008)
0.0065
(0.005)
0.0041
(0.001)
0.0179
(0.001)
0.0024
(0.398)
 0.0026
(0.003)
0.0000
(0.998)
0.0581
(0.006)
0.0032
(0.000)
 0.0066
(0.000)
0.0063
(0.024)
 0.0096
(0.000)
0.0111
(0.071)

0.0023
(0.001)
 0.0066
(0.001)
 0.0062
(0.002)
 0.0027
(0.004)
 0.0187
(0.000)
 0.0047
(0.033)
0.0020
(0.003)
0.0039
(0.001)
 0.0569
(0.006)
 0.0031
(0.000)
0.0045
(0.004)
 0.0075
(0.001)
0.0072
(0.000)
 0.0120
(0.021)

 0.0007
(0.338)
0.0040
(0.006)
 0.0075
(0.025)
0.0041
(0.001)
0.0008
(0.518)
0.0013
(0.401)
 0.0025
(0.003)
0.0013
(0.142)
0.0000
(0.992)
0.0017
(0.152)
0.0032
(0.000)

Tunisia
Ukraine

a0

a1

b0

b1

0.2784
(0.000)
0.3932
(0.000)
0.3486
(0.000)

 0.4602
(0.001)
0.3630
(0.002)
 0.4935
(0.001)

0.0017
(0.269)
 0.0052
(0.002)
0.0023
(0.231)

are 0.0849, 0.4630, and 0.0000, respectively. These results

indicate no trend in integration through time, but a large
positive shift in integration following the breakpoint. The
breakpoint for Romania corresponds to its entry in the EU.
The remaining estimates in Panel C indicate decreases in
integration for the respective countries subsequent to the
breakpoint. Overall, the results in Table 6 show that
interesting dynamics relating to world market integration
can be captured with the structural break approach.
To further analyze integration dynamics, we present
tted values from the dummy-variable regressions. Specically, for each country with an identied signicant
breakpoint, we report tted values of the regression 12
and 6 months prior to the breakpoint, and 6 and 12
months after the break point. The tted values indicate
the overall level of integration for the country, as well as
dynamics surrounding the breakpoint. Panels AC of
Table 7 present tted values for countries with an
identied breakpoint in the constant and time-trend, the
time-trend only, and the constant only, respectively.
The results in Table 7 indicate increasing and decreasing levels of integration surrounding breakpoints for
different countries. The results also indicate consistency
across countries for which multiple breakpoint tests
identify the same calendar month. For example, prior to
the breakpoint and based on the model with a change in
the trend term reported in Panel B, the overall level of
integration for Argentina was low, and slightly decreasing
from 0.115, 12 months prior to the break, to 0.110, 6
months prior to the break. Following the identied breakpoint, Argentinas overall level of integration increases
rapidly to 0.452 at 6 months post-breakpoint, and then
continues to increase to 0.461 at 12 months post-breakpoint. Results from Panel C, which reports models that
allow a breakpoint in the constant term, indicate tted
values of 0.127 and 0.123, 12 and 6 months prior to the
breakpoint, respectively, while the corresponding values
after the breakpoint are 0.484 and 0.480. Therefore,
results based on both a changing constant, and a changing
trend term, indicate low levels of integration before a
breakpoint for Argentina that are approximately equal to
0.1. Following the identied breakpoint of October 2005,
the measure of integration remains relatively stable
around 0.5. Results in both Panels B and C indicate that
Kenya, Romania, and Tunisia all experience rapid
increases in their level of integration following the identied breakpoints. However, the Ukraine and other countries experience decreasing levels of integration following
the breakpoints.

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Table 7
Structural break model tted values.
This table reports tted values from structural break regression
models. We estimate

239

frontier markets, we show the diversication benets across

frontier indexes using an efcient frontier. The low R-squares
imply that the frontier market indexes cannot be replicated
by weighting stocks in another country.

adjR2t a0 a1 breakt b0 t b1 tbreakt et ,

in which adjR2t represents the adjusted R-square from the Pukthuanthong
and Roll (2009) principal component approach during monthly sample t, t is
an ordinal time-trend variable, and breakt is a dummy variable taking the
value of zero for all observations prior to the identied breakpoint, and
taking the value of one otherwise. Entries under column headings, BP  12,
BP  6, BP + 6, and BP + 12 represent tted values of adjR2t 6 and 12 months prior
to, and six and 12 months after the identied breakpoint, respectively.
Quandt-Andrews Breakpoint test identify signicant breakpoints for each
country. Panels AC present tted values for countries with an identied
breakpoint in the constant and time-trend, the time-trend only, and the
constant only, respectively.
BP  12

BP  6

Panel A: Breakpoint in constant and time-trend

Slovenia
0.4590
0.4788
Panel B: Breakpoint in
Argentina
Botswana
Bulgaria
Croatia
Ghana
Jamaica
Kenya
Romania
Saudi Arabia
Slovenia
Sri Lanka
Trinidad and Tobago
Tunisia
Ukraine

time-trend
0.1146
0.5445
0.2844
0.3213
0.5132
0.3783
 0.2416
0.0852
 0.0734
0.4559
 0.0330
0.4283
0.1036
0.3982

Panel C: Breakpoint in constant

Argentina
0.1271
Botswana
0.5207
Bulgaria
 0.1095
Croatia
0.3230
Ghana
0.4412
Jamaica
0.3928
Kenya
 0.2273
Pakistan
0.1913
Romania
0.0849
Saudi Arabia
0.3420
Slovenia
0.4569
Trinidad and Tobago
0.3600
Tunisia
0.1696
Ukraine
0.4038

BP + 6

BP + 12

0.1344

 0.0624

0.1098
0.5859
0.3234
0.3459
0.6206
0.3927
 0.2572
0.0852
0.2752
0.4751
 0.0726
0.4661
0.0460
0.4648

0.4521
0.2265
 0.0946
0.0927
0.0313
0.1066
0.0636
0.5493
 0.0518
0.0175
0.1767
0.0467
0.3700
0.0940

0.4611
0.2283
 0.0928
0.1011
0.0265
0.0928
0.0600
0.5727
 0.0446
0.0181
0.1641
0.0395
0.3556
0.0886

0.1229
0.5447
 0.1545
0.3476
0.4460
0.4006
 0.2423
0.1991
0.0849
0.3522
0.4761
0.3702
0.1384
0.4176

0.4837
0.0814
0.3198
0.0728
 0.0613
 0.0518
0.1170
 0.1674
0.5479
 0.0858
0.0266
 0.0696
0.4390
 0.0483

0.4795
0.1054
0.2748
0.0974
 0.0565
 0.0440
0.1020
 0.1596
0.5479
 0.0756
0.0458
 0.0594
0.4078
 0.0345

4. Diversication benets of frontier market equities

The results presented within Section 3 indicate that broad
frontier market indexes exhibit a low level of world market
integration. Considering event-specic risk, Speidell and
Krohne (2007) argue that frontier market volatility is not
driven by the same factors that inuence volatility within
developed markets. In the context of Solnik (1974), if frontier
market volatility is largely attributable to country-specic
risk, and not driven by global factors, then frontier market
diversication will reduce portfolio risk. In our study, we
analyze the diversication benets of broad frontier indexes
relative to a broad diversied portfolio across market classications. Since we observe low levels of integration within

4.1. Mean-variance frontier

We graphically document the potential performance gains
from frontier market diversication by plotting the meanvariance frontier formed from three benchmark asset portfolios, namely, the US market, the MSCI Developed Markets
Index, and the MSCI Emerging Markets Index, as well as the
potential mean-variance frontiers formed by augmenting the
three benchmark asset portfolios with either the valueweighted or equal-weighted frontier index. Results allowing
short sales and results with short-sale restrictions are presented in Figs. 2 and 3, respectively.
Large portfolio improvements accrue through the inclusion of frontier indexes. The graphs suggest a 2% reduction in
risk, while maintaining a given level of expected return when
the equal-weighted frontier index is included, as well as a 1%
reduction based on the value-weighted index. Interestingly, it
seems that the equal-weighted index offers incremental
portfolio improvement beyond the value-weighted index.
This indicates that smaller markets may have offered superior performance during the sample, or may exhibit a lower
relation with global factors.
The mean-variance frontiers form optimal portfolios
based on ex-post information. An analysis of out-ofsample performance can determine if diversication benets exist with ex-ante information. We maintain the
portfolio grouping designations from Figs. 2 and 3, in
which Portfolio 1 includes the benchmark market classication portfolios, and Portfolios 2 and 3 augment Portfolio 1 with the value-weighted frontier index and equalweighted frontier index, respectively. Optimal portfolio
weights are calculated with a 5-year estimation period,
and then carried forward for the following calendar year.
Given each portfolio grouping and ex-ante portfolio allocation, a time-series of monthly Sharpe ratios is calculated. The 3-month T-bill rate proxies for the risk-free
rate. Summary statistics of the Sharpe ratios for each
portfolio are reported in Table 8.
Out-of-sample performance tests conrm the diversication benet of frontier markets. Results with and
without short sales indicate substantial portfolio
improvement from including frontier indexes. The mean
and median Sharpe ratios for both Portfolios 2 and 3 are
signicantly greater, when compared to Portfolio 1, in all
cases considered. For example, the mean monthly Sharpe
ratio for Portfolio 3 is equal to 0.36 when short sales are
prohibited, while the comparable estimate for Portfolio 1
is only equal to 0.20.6
6
We perform the same analysis during the period before 2008 and
nd that Sharpe ratios are higher. This implies that the diversication
benet has decreased since 2008 but it still exists. Overall, the result in
this section is consistent with our correlation analysis where we nd
correlation has increased since 2008.

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Expected return

240

0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
0.11

Mean-variance frontier

Portfolio 1
Portfolio 2
Portfolio 3
0.12

0.13

0.14

0.15

0.16

0.17

0.18

Standard deviation

Expected return

Fig. 2. Mean-variance frontiers allowing short sales. This gure depicts mean-variance frontiers for portfolios formed from market classication indexes.
Portfolio 1 includes the US market, the MSCI World Index representing developed markets, and the MSCI Emerging Markets Index. Portfolios 2 and 3
augment Portfolio 1 with the value-weighted and equal-weighted frontier indexes, respectively. The sample period is from 1989 to 2009.

0.12
0.1
0.08
0.06
0.04
0.02
0
0.11

Mean-variance frontier

Portfolio 1
Portfolio 2
Portfolio 3
0.115

0.12

0.125

0.13 0.135 0.14

Standard deviation

0.145

0.15

0.155

0.16

Fig. 3. Mean-variance frontiers restricting short sales. This gure depicts mean-variance frontiers for portfolios formed from market classication
indexes. Portfolio 1 includes the US market, the MSCI World Index representing developed markets, and the MSCI Emerging Markets Index. Portfolios 2
and 3 augment Portfolio 1 with the value-weighted and equal-weighted frontier indexes, respectively. The sample period is from 1989 to 2009.

Table 8
Sharpe ratios based on out-of-sample weighting.
This table presents summary statistics of Sharpe ratios across portfolios based on out-of-sample portfolio weights. Portfolio 1 includes the US market,
the MSCI World Index representing developed markets, and the MSCI Emerging Markets Index. Portfolios 2 and 3 augment Portfolio 1 with the valueweighted and equal-weighted frontier indexes, respectively. Optimal portfolio weights are calculated at the start of each calendar year, based on the
previous 5 years of monthly data. Weights are maintained for the following 12 months. Sharpe ratio summary statistics are calculated based on the
monthly time-series for each portfolio. The risk-free rate is the 3-month T-Bill rate. The symbol *** indicates that the mean or median statistic for
Portfolio 2 or for Portfolio 3 is signicantly larger than the comparable statistic for Portfolio 1 at the 1% level.
Short sales allowed

Mean
Median
Max
Min
Std

Short sales prohibited

Portfolio 1

Portfolio 2

Portfolio 3

Portfolio 1

Portfolio 2

Portfolio 3

0.3048
0.3232
0.6992
 0.1567
0.1750

***0.3913
***0.3861
0.7265
0.0237
0.1336

***0.4926
***0.4178
1.1151
0.0619
0.2980

0.2022
0.2104
0.4916
 0.0883
0.1489

***0.2630
***0.2868
0.5657
 0.0681
0.1370

***0.3566
***0.3193
1.0323
 0.0883
0.2992

4.2. Exchange-traded funds

Bekaert and Urias (1996) argue that analyses based on
non-investable indexes may overstate diversication benets. Given the nature of frontier markets, it is likely that
barriers to investment exist. The recent advent of frontier
market ETFs allows an analysis of diversication benets
based on investable indexes. The ETF analysis measures
potential investment benets from a nave diversication
strategy, or to investors who do not have access to

individual stocks, and does not properly measure diversication potential for better-equipped and more sophisticated investors. However, the ETF analysis represents a
conservative hurdle by which to measure diversication
benets. That is, if we show benets from a nave ETF
investment, it is likely that signicant diversication
benets exist to more sophisticated investors.7

We thank the referee for making this point.

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

241

Table 9
Portfolio risk and return across ETFs.
This table presents summary statistics for international portfolios. Portfolios are formed with exchange-traded funds in which EEM represents the MSCI
Emerging Markets Index ETF, FRN represents the frontier market ETF, SPY represents the S&P 500 ETF, and VEU represents the FTSE All-World excluding
US ETF. ETF characteristics are reported in Panel A for the given samples. In Panel B, portfolio characteristics are reported for various weighting schemes.
The portfolio weighting schemes are dened as the portfolio weights to the EEM, FRN, SPY, and VEU funds, respectively. Returns are in percentage form.
July 1, 2008 to February 26, 2010
Holding period
return

July 1, 2008 to March 9, 2009

March 10, 2009 to February 26, 2010

Annualized standard
deviation

Holding period
return

Annualized standard
deviation

Holding period
return

Annualized standard
deviation

60.66
41.32
36.82
43.92

 53.62
 60.24
 46.04
 54.35

85.29
50.08
50.35
58.61

91.45
96.19
66.35
79.81

33.53
32.96
22.38
28.84

Panel B: Risk-return statistics across portfolio weights

Portfolio weights
(EEM,FRN,SPY,VEU)
0.30,0.00,0.40,0.30
 11.46
44.99
0.20,0.10,0.40,0.30
 12.03
41.80
0.25,0.10,0.40,0.25
 11.54
42.60

 50.30
 50.84
 50.72

61.85
56.72
58.00

78.14
78.94
79.52

26.98
26.11
26.34

Panel A: ETF risk-return statistics

EEM
 11.21
FRN
 22.00
SPY
 10.23
VEU
 17.89

Due to the limited available history, we focus on

presenting measures of portfolio risk and return across
varying levels of international diversication. We focus on
exchange-traded funds representing the ex-USA Developed Markets, the S&P 500, the MSCI Emerging Markets
Index, and frontier markets, and denote these ETFs based
on their ticker symbols as VEU, SPY, EEM, and FRN,
respectively. Summary statistics are presented for each
ETF across the entire sample for which the frontier market
ETF is available, July 2008 through February 2010, as well
as across the sample from July 1, 2008 through March 9,
2009 which represents a period of extreme market
decline in which the S&P 500 fell approximately 25%,
and the sample from March 10, 2009 through February
26, 2010 in which the S&P 500 gained approximately 65%.
We also construct portfolios across the developed and
emerging market ETFs and then analyze the diversication benets of frontier markets by shifting portfolio
weights towards the frontier market indexes. We conduct
comparisons across a variety of portfolio weighting
schemes. The portfolio weights reported are arbitrarily
selected for a typical international investor, but the
results and conclusions do not change with different
combinations of portfolio weights. We present results in
Table 9.
Results in Table 9 indicate that the inclusion of the
frontier market ETF reduces the annualized standard
deviation of a diversied portfolio. Results hold for the
bear and the bull markets. During the bull market, the
inclusion of FRN not only reduces risk but also increases
return.8 It should be noted that the FRN fund inception
date was June 12, 2008, but the analysis starts on July 1,
2008 to avoid the inuence of any abnormal trading that
8
In unreported analyses, mean-variance spanning tests indicate
signicant diversication benets of both broad frontier market indexes,
as well as country-specic indexes. These results are available from the
authors upon request.

might occur when the fund was rst introduced to the

market.

5. Conclusions
This study considers returns from frontier market
countries, as well as broad frontier market indexes. The
results relate to signicant prior literature that investigates levels of world market integration, as well as the
diversication benets of international investing. These
two broad topics are related as nance theory implies an
inverse relationship between international diversication
benets and levels of world market integration. However,
we uniquely focus on frontier markets, which previously
have received relatively little attention. We nd little
evidence of frontier market integration within the world
market and a lack of consistent integration dynamics.
However, our structural break models indicate periods of
increasing and decreasing integration for specic frontier
market countries.
The results we obtain from this study are robust. The
subperiod analysis, out-of-sample performance test, and
use of ETFs conrm our overall results that frontier
markets are not integrated and thus, provide international
diversication benets when they appear in a diversied
portfolio that includes developed and emerging equities.
Although we feel condent that frontier markets provide
diversication benets to international investors, further
studies are needed to address remaining issues related to
asset pricing in frontier markets.

Appendix A. Frontier market macro-economic variables

See Table A1.

242

D. Berger et al. / Journal of Financial Economics 101 (2011) 227242

Table A1
The table presents the economic variables of the frontier markets within our sample. All variables are presented in US$. With the exception of GDP per
capita, all GDP and market capitalization represent billions of dollars. Average GDP growth is in percentage form. Average GDP and average GDP growth
are based on data covering 1993 through 2008 (or 2007 for Oman and UAE), while average market capitalization is from 1993 (or the year when data
became available) to 2009. Data are from the World Development Indicator of the World Bank.
Country

Argentina
Bahrain
Botswana
Bulgaria
Croatia
Estonia
Ghana
Jamaica
Jordan
Kenya
Kuwait
Lebanon
Lithuania
Mauritius
Nigeria
Oman
Pakistan
Romania
Saudi Arabia
Slovenia
Sri Lanka
Trinidad and Tobago
Tunisia
Ukraine
UAE

2008 GDP
per capita

2008
GDP

Average
GDP

Average
GDP growth

2009 Market
capitalization

Average
market
capitalization

8236.00
28,240.00
6982.00
6546.00
15,637.00
17,454.00
713.00
5438.00
3596.00
783.00
54,260.00
6978.00
14,098.00
7345.00
1370.00
B15,273.00
991.00
9300.00
19,022.00
27,019.00
2013.00
18,108.00
3903.00
3899.00
B45,531.00

328.46
21.90
13.41
49.90
69.33
23.40
16.65
14.61
21.24
30.35
148.02
29.26
47.34
9.32
207.12
B41.64
164.54
200.07
468.80
54.61
40.56
24.15
40.31
180.35
B198.69

239.10
9.81
7.35
19.64
31.85
9.36
8.43
9.07
10.20
15.17
53.57
17.97
17.72
5.22
72.02
21.04
84.97
68.08
224.28
27.21
19.37
10.55
23.51
67.39
81.44

3.69
5.63
5.38
2.81
3.44
5.19
4.88
1.44
5.50
3.19
7.20
4.06
3.56
4.63
4.25
4.27
4.19
3.63
2.75
4.31
5.25
5.81
4.63
 0.19
6.00

48.03
16.93
4.28
7.33
26.62
1.70
2.51
6.13
31.89
10.97
96.32
12.89
4.62
4.98
33.37
17.30
32.21
31.32
318.74
12.14
8.17
11.15
9.31
16.86
109.61

72.20
13.50
1.91
4.10
12.66
2.83
1.62
5.97
15.28
4.59
57.30
4.45
3.73
2.28
16.46
7.73
20.70
11.09
180.74
6.91
3.45
7.65
3.51
19.12
80.76

B indicates that the gure is based on 2007 data as 2008 data are not available.

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